- The S&P 500 fell over 4% yesterday.
- Declines over 3% are common in bear markets, and they can provide investors with a profit-friendly buy opportunity over time.
- Treasuries are challenging support amid poor sentiment, potentially setting up a trade long.
The S&P 500’s tumble yesterday wasn’t the first down 4% day this year. The S&P 500 also fell over 4% on May 18th, two days before a 10% rally that lasted until the end of the month. Nobody knows what happens this time, but buying big down days can pay off short-term, and it’s always made you money if you’re a long-term investor.
For instance, there were 33 down 3% or more days on the S&P 500 during 2008, including 11 horrible down 5% plus declines. Fast forward to today, and every one of those turned out to be a very profit-friendly moment to buy. Heck, you’d even be smiling proudly if you had bought it in September 2008 before the bloodbath that took the index down to its March 2009 lows. Of course, it felt awful during that decline, but you’d be sitting on a handsome profit today.
The takeaway? Be careful about extrapolating lousy news into the future. Big down days can cluster, and stocks could undoubtedly go lower before going higher again, but volatility is typical in a bear market, and significant declines can create opportunities.
How to navigate stock volatility
In “Tuesday's Drop Was Temporary Insanity (And the Keyword Is Temporary),” Real Money Pro's Paul Price writes, “What can you do when "the market" ignores facts and trades strictly on emotion? The best thing is to keep plugging along on what you know makes sense…Temporary insanity is, by definition, temporary. Craziness cannot persist over the long term. It rarely lasts longer than weeks or months.”
Price highlights how indiscriminate yesterday’s sell-off was using Children’s Place (PLCE) as an example. He writes:
“Children's Place dropped a stunning 13.37%, on Tuesday, hitting a new 52-week low in the process. Shares that fetched $113.50 last November were available at $34.91 intraday…PLCE posted $13.40 in adjusted earnings per share in fiscal 2021 (ended Jan. 29, 2022) and is still on track for about $7 in EPS this year without the aid of economic stimulus or child tax credit payments…At $35 or so, it sells for around 5-times earnings vs. a more typical 16 - 17 multiple.”
A revaluation of multiples is common during bear markets. Still, in Price’s opinion, that re-rating can get overdone, creating chances for investors to step in and buy profitable companies trading at a historically low price-to-earnings multiple.
Back to Price:
“Even the best investors must suffer through periods when their selections seem "out of step" with current viewpoints…That is why I spend so much time determining what the stocks I recommend are really worth. I'd never expect readers to buy a stock simply because, "I said it looks good...If stocks you like get cheaper than you ever thought possible ... consider buying more to average down.”
Price isn’t the only one who views yesterday’s sell-off as a potential opportunity. In his diary, Real Money Pro’s Doug Kass wrote this morning:
“A day ago with the S&P Index at about 4150, I suggested that traders/investors should "yell and roar and sell some more...Today with the S&P Index at about 3925, I would suggest that traders/investors should consider to begin to start buying…I do not expect the market to breach its 2022 lows to the downside over the remainder of the year as many of my concerns are becoming discounted in lower equity prices.”
Kass is operating under the belief that the S&P 500 will remain range bound between “3825-4225 over the balance of 2022.” So, as a result, he’s trimming net long exposure when the reward-to-risk is low because the index is nearing the high end of the range and increasing exposure when it is high because the index is at the lower end of the range like it is now.
What’s Kass buying? He writes, “My message of the week last week was to buy banks…My message this week is to buy banks.”
It could be a good time to buy bonds
Stocks aren’t the only place where recent selling may create buy opportunities. In “The Fed Isn't Draining Liquidity, They Are Soaking It Up With a Q-Tip,” Real Money Pro’s Carley Garner points out that the long U.S. Dollar trade is becoming crowded, and eventually, those dollars are likely to search for a new home.
“With stocks, bonds, and even most dollar-denominated commodities on a downswing, there could be quite a bit of dollar deposits sitting in cash. At some point, that cash will likely either need to be allocated somewhere or moved back into other currencies…Where will all of this money go?...The bond market has had one of its worst years on record, particularly Treasuries. For decades, the Federal Reserve has maintained a goal of price stability, but one might argue their efforts have done the opposite. Quantitative easing and its unwind have led to progressively higher highs and more volatile lows for bonds on the long end of the curve. However, the 30-Year Bond is as oversold as it has ever been and offers a yield not seen since before the financial crisis…Will this be a place for sidelined cash to be put to work? Maybe not today, but at some point, the odds of much larger allocations to duration are high.”
The Treasury carnage this year has taken a toll on investors embracing the 60/40 stocks to bonds split as a way to reduce risk. However, with long bonds trading at 2008 levels and bond sentiment bordering on terrible, at a minimum, buying a Treasury bond ETF such as the iShares 20-year Treasury Bond ETF (TLT) for a trade could pay off.
Top Stocks' Helene Meisler points out in “Down and Bounce?” that the Daily Sentiment Index for bonds is at 12, nearing an actionable single-digit reading. Given that the TLT is trading at the low end of its down channel, Meisler thinks it could be a trade long.
The Smart Play
Stocks could continue chopping about within Kass’ expected trading range. If so, traders can fade the upper end and buy the lower end until the S&P 500 action suggests that the range is no longer valid.
It may also be a good time to allocate some money toward bonds, such as the TLT, or if you’re risk averse, short-term Treasuries. After all, it’s relatively easy to spot the exit point, given bonds are trading near their lows. If you buy the 1-year Treasury, you can get a relatively juicy 3.9% yield.
If you’re a long-term investor, remember that bear markets often create opportunities for long-term gains. Eventually, the baton will be handed back to the bulls, and when that happens, you want to be positioned to make the most of it. It’s for this reason that I keep recommending increasing the amount you dollar cost average each month to an S&P 500 fund. Doing so increases the number of shares you own, reducing your average cost, which may allow you to recapture your prior peak account value more quickly.